DSE ARTICLE:Pension Reforms, Capital Markets and Economic Development (III)


In recent years, a growing number of emerging markets economies (African included) as well as most advanced countries have witnessed growth of pension funds as institutional investors. This has often occurred in the wake of pension reform shifting retirement income provision from pay-as-you-go to funding especially as finding the right balance between the ageing of the population and financing difficulties of pay-as-you-go systems come into play. We also have embarked in the pension sector reform for our own reasons. Accordingly, in the last few weeks I have tried to analyse the impact of such reforms and effect in institutional investments on our economy, upon their successful implementation. In this context, my mission was to indicate how reformed pensions funds as institutional investors in financial sector development, as well as the wider effect in the country’s financial development and economic performance -- including economic empowerment, financial literacy and inclusive economic and social prosperity.

In recent days, there have been some arguments that as an economy and with our small savings, it is difficult to finance key sectors of our economic development such as infrastructure, power, energy, mining, gas, etc using our local savings and capital – that external capital and institutions possess the capability to invest in such sectors. In this regard -- won’t we need to ask ourselves: where do those external funding (either in the form FDIs, strategic investment funds, portfolio investment funds, or private equity funds) are sources from? As I indicated in my last week’s article, a significant portion of these external funds are generated and packaged from pension funds, family wealth funds, sovereign wealth funds, etc and are intermediated through capital markets. I also indicated that globally pension funds provide more than a quarter of all of all new capital investment available for investment.

I am not propelling an idea that we become naïve and blind to understand our practical situation – which is, we are a small country with minimal financials resources – what I am trying to say is: we should work in developing our local long term financial intermediation institutions through devising structures, developing (or enhancing) our capital markets infrastructural value chain, enhance existing systems, etc -- so we may build strong institutions that will unlock the existing private and capital, and then develop capabilities to mobilize local savings (capital) co-finance in key infrastructure projects and mandates. It is important we understand that across the financing and investment space: investments gains (of whatever form) tend to follow their source of capital. That the best sustainable and progressive form of capital is made at home – it is difficult to sustainably grow our economy or develop an inclusive economy while we constantly depend on external capital, the minimum we can do is having the right mix of both domestic and foreign capital.
Furthermore, as an economy we sit in almost Tshs. 30 trillion worth of recorded (formal) savings mobilized through banks, pension, insurance – these are largely invested in short term assets i.e. commercial bank lending and government securities. Because of structural imbalances and lack of long term financial intermediation institutions these funds are not invested in long term key projects such as mining, power, energy, gas explorations, railway, port, or airports infrastructure. As we engage in discussions about incapability of local funds to invest in sizable local projects, probably we should also discuss on how may leverage on the abundance of available resources, turn them into capital that then get invested in areas that will improve our communities’ social and economic welfare and an inclusive prosperity.

Continued overreliance of international investment, largely mobilized from well structured and strategized foreign pension funds is a loss of potential and a missed opportunity to develop not only the domestic capital formation through the capital market by also will continue to pose us into a risk of capital flight or rather capital (and gains from capital) going back to where it came from.
The other reasons that make me strongly believe in pension funds, as a key source of long-term capital is that pension funds growth have institutional implications and affects on the depth and variety of financial system. Notably, pension funds are complimentary with the development of banks, insurance companies (especially life, disability and annuity insurance) and assets management, and collective investment schemes (i.e. unit trusts/mutual funds) – all these have a significant positive impact in the financial sector development and the economic performance at large.
A vibrant pension sector has much positive linkage to banks – pension funds, upon their growth sometimes are competing intermediaries with banks for either house hold savings, corporate financing, or via money markets as holders of money market instruments that compete with bank deposits. Such healthy competition may increase the efficiency of the banking sector, benefiting the non-financial sector via lower interest rate spread and hence lowering the cost of access to capital markets. When in such situations, I would bet that banks may respond to the associated pressure on their profits partly by increasing their focus on non-interest income – including assets management income, mutual funds and insurance – and reducing excess capacities or concentrating on their core comparative advantage such as lending to small businesses which in its generality improve their efficiency and spur financial system and economic growth.

In the other side, pension funds may also be complimentary to banks where they invest in medium term bank deposits and in some cases when banks are in need to avoid mismatch challenges pensions funds may purchase long-term debt liabilities (corporate bonds) issued by banks.
Besides the quantitative effects that we so far have noted, development of pension sector through reforms would likely trigger qualitative developments in the financial markets i.e. promoting better resources allocation, improvements in financial innovation, which may include investment in our local securities junior market (Enterprise Growth Market - EGM), corporate bonds market development, as well as development of securitization and financial derivative products. For us in the capital market, we should be mindful of the fact that modernization of our infrastructure of securities markets as may be required by a growing and vibrant pension sector should entail improved clearing and settlement one hand and timely sharing price sensitive information. As a consequence this will help reduce the cost or increase the availability of capital market funds, and hence industrial (and other key development sector) development and growth as well as facilitating privatization.

Let me conclude by saying, there is normally a radical change in financial structure, from short term assets (such as bank savings and deposits) towards long term assets (such as equities and bonds) as pension funds reforms and grow. In supporting the idea of a shift to long term assets as pension funds grow, the case of Chile may be a reference – in there, they observed a strong cross sectional correlation between equity market capitalization and liquidity and the size of pension fund sector. The same applies the whole bonds market where there is a strong colleration for bonds markets growth with pension funds growth.